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Sources of Finance SOURCES OF FINANCE Excerpt from: www.ehow.co.uk/facts_6741037_definition-sources- finance.htmlw www.bized.co.uk./learn/accounting/financial/sources/index. htmlw PART 1 Function LEARNING OUTCOMES For many businesses, the issue about where to get funds from for starting up, development and expansion can be crucial for with regard to the success of the business. It is important, therefore, that you With the” merger" different funds understand the various sources of finance open to a business two or more used in a and are able to assess how appropriate these sources are in companies join enterprise relation to the needs of the business. together in a students should unique business A finance source, or financing method, helps an organization to be able to satisfy short-term operating needs, such as paying for costs of describe what materials, salaries and other administrative expenses. Financing are internal and also helps leadership plan for long-term such as expansion external projects ( mergers and acquisitions). financial sources and the Significance differences among these. Financing is a significant business practice in modern economies. A firm with no access to financial markets, or unable to raise funds privately, may have difficulties operating. Senior leaders may be unable to set long-term goals without funding. Types There are external and internal sources of finance; the types Equity is the amount of financing products vary, but the most common are equity and debt products. Equity products include shares of common of the funds stock and preferred stock. Debt products include bonds, private contributed by the loans and overdraft agreements. owners (the stockholders) ;it is Internal Sources also the amount of the stocks issued Traditionally, the major sources of finance for a limited company are internal sources: Personal savings Retained profit Working capital Sale of assets To recruit means to enroll Personal Savings or to hire new Quite simply, personal savings are amounts of money that a members business person, partner or shareholder has at their disposal to ( employees ) do with as they wish. If that person uses their savings to invest in their own or another business, then the source of finance on behalf of an comes under the heading of personal savings. employer There are many examples where business people have used substantial sums of their own money to help to finance their businesses. A good and very public example here is Jamie Oliver, the television chef. Jamie financed his new restaurant, 'Fifteen', using fifteen raw recruits to the catering trade and a large amount (£500,000) of his own cash. Retained Profit PROFIT This is often a very difficult idea to understand but, in reality, it is very simple. When a business makes a profit and it does not spend it, it keeps it - and accountants call profits that are kept and not spent retained profits. That's all. The retained profit is then available to use within the business to help with buying new machinery, vehicles, computers and so on or developing the business in any other way. Retained profits are also kept if the owners think that they may have difficulties in the future so they save them for a rainy day! “Rainy day”stands Working Capital for” the future time of need” This is the short-term capital or finance that a business keeps. Working capital is the money used to pay for the everyday trading activities carried out by the business - stationery needs, staff salaries and wages, rent, energy bills, payments for supplies and so on. Working capital is defined as: Working capital = current assets - current liabilities Where: Cash in hand means funds current assets are short term sources of finance such as debtors that are and cash - the amount of cash and cash equivalents - the immediately business has at any one time. Cash is cash in hand and deposits available to a payable on demand (e.g. current accounts). Cash equivalents business, and are short term and highly liquid investments which are easily can be spent as needed and immediately convertible into cash. current liabilities are short term requirements for cash including trade creditors, tax owing, dividends owing - the BALANCE SHEET amount of money the business owes to other people/groups/businesses at any time that needs to be repaid Assets Liabilities within the next month or so. Long Equity term Sale of Assets assets Business balance sheets usually have several fixed assets on them. A fixed asset is anything that is not used up in the Short Liabilities production of the good or service concerned - land, buildings, term fixtures and fittings, machinery, vehicles and so on. At times, assets one or more of these fixed assets may be surplus to requirements and can be sold.( the entrepreneur might have a capital gain or capital loss). Alternatively, a business may desperately need to find some cash so it decides to stop offering certain products or services and because of that can sell some of its fixed assets. Hence, by selling fixed assets, business can use them as a source of finance. Selling its fixed assets, therefore, has an effect on the potential capacity of the business . Office buildings may be part of a firm's assets that could be sold off in times of slowdown in activity to raise finance. KEY POINTS INTERNAL SOURCES: amount of capital made by the activity of business PERSONAL SAVINGS: own money not used to buy goods or services RETAINED PROFIT: profit made by the activity of the business and not spent WORKING CAPITAL: short-term capital used in a business to pay current liabilities SALE OF ASSETS: sale of assets used in a firm( machinery, buildings, land,..) External sources/Non-Ownership Capital The principal types of debts are: Ownership capital Debt financing Overdraft facilities Lines of credit from creditors Grants Venture capital Factoring A dividend is a payment Leasing made by a corporation to its shareholder as a distribution of profits. (equity financing) Ownership Capital In this context, 'owners' refers to those people/institutions who are shareholders. Sole traders and partnerships do not have shareholders - the individual or the partners are the owners of the business but do not hold shares. Shares are units of investment in a limited company, whether it be a public or private limited company. Equity financing helps top leadership raise funds by selling shares of equity, or stocks, on securities exchanges. A shareholder, also called stockholder, receives regular dividend payments and makes profits when share prices rise. Shares can be issued and paid either: at par, at a premium. Shares can be issued and paid by instalments An annual general Shares are generally broken down into two categories: meeting is a meeting that official bodies and Ordinary shares associations involving Preference shares shareholders. An AGM is held every year to elect the board and inform Ordinary Shares their members of previous and future Ordinary shares are also known as equity shares and they are activities and to approve the most common form of share in the UK. An ordinary share the balance sheet gives the right to its owner to share in the profits of the AN ORDINARY SHARE company (dividends) and to vote at general meetings of the company. Since the profits of companies can vary wildly from year to year, so can the dividends paid to ordinary shareholders. In The primary market is bad years, also known as new issues dividends may be nothing whereas in good years they may be substantial. Some businesses may choose to pay marketout a dividend. Here, the even if it has had a difficult trading year and hastransaction made a loss is. conducted between the issuer and The nominal value of a share is the issue value ofthe the buyer. share - it is the value written on the share certificate that all shareholders will be given by the company in which they ownIn shares. secondary market,( second hand market or The market value of a share is the amount at whichaftermarket) a share is the being sold on the stock exchange and may be radicallysecurities different issued in the from the nominal value. primary market are bought and sold. Here, When they are issued, shares are usually sold for cash, at par you can buy a share and/or at a premium. Shares sold at par are sold for their nominal value only . directly from a seller and the stock exchange or If a share is sold at a premium, as many shares brokerare these actsdays, as an then the issue price will be the par value plus an intermediaryadditional between premium. two parties.[ PART 2 Ordinary shares are the riskiest form of investment in a company since there may be no dividends paid and the market value of shares might fall after they have been bought. A very good example of the latter case relates to shares in Ryanair - take a look at this graph of their share price. Data source: Yahoo Finance The price can The Ryanair share price fell so dramatically in mid-January 2004 because the company announced that its profits for the Increase plummet current financial year would probably be worse than they had previously expected. Marconi corporation plc suffered a similar fate in terms of its share price which suddenly collapsed following announcements of serious financial problems within the group. Take a look at how their share price has since recovered: Private limited company offers limited liability for its shareholders but it places certain restrictions on its ownership, defined in Don't forget that the stock market is actually just a second the company's by laws hand share market so even though no company ever wants its or regulations and are share price to collapse.
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